Introduction
Companies can use different ways to categorize or classify costs. The most common ways of categorizing costs include by nature (material, labor, expenses), by function (distribution, selling and administration), direct or indirect and by variability (variable or fixed cost). In economics, costs are mainly classified as either fixed or variable cost. Classification of cost plays a significant role in the determination of accounting and economic profit. Accounting profit is determined by GAAP while economic profit is determined by economic principles. In this assignment, the four-cost categorization listed above will be employed to measure and estimate costs in NVIDIA Corporation. NVIDIA is an American multinational company that design and graphics processing units for gaming and processing units.
Classification by Variability/Fixed or Variable Cost
Under this category, costs are classified as either variable or fixed costs. Variable cost changes when the level of volume fluctuates. They are costs that are directly incurred in the production of a unit of output (Gwartney, Stroup, Sobel, & Macpherson, 2017). Fixed costs are costs that are not directly incurred in the production of a unit output and hence cannot be associated with a particular cost center. Consequently, they remain fixed irrespective of changes in volume. Examples of fixed costs include management remuneration, insurance, and rent. There are different methods that can be used to measure and estimates fixed costs in the technology industry. The most effective method is gross costing which looks at the total cost of insurance over time and the average cost of consumption per period (Gwartney et al., 2017). This method is considered effective because it takes into account insurance costs over a long period and averages it to determine the cost per period.
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Direct and Indirect Cost
Direct costs are identified with a particular cost center or are can be traced in the end-product. Indirect costs are incurred for the benefits of many cost centers such as management salary. One effective way of calculating direct costs are the direct costing method that only considers all the costs that can be directly identified with the end-product (Gwartney et al., 2017). Specifically, software costs can be estimated based on the production level.
Classification by Distribution
This cost classification method is based on the purpose for which they are incurred. Costs are classified based on the division of activity such as selling, distribution and production cost. These costs can be estimated using a predetermined rate based on the activity level (Gwartney et al., 2017). For instance, distribution cost can be estimated as a percent of production cost or sales. If the company made sales amounting to $4,000,000, distribution cost can be estimated at 5% of total sales ($200,000).
Classification by Nature
Under this category, costs are divided into material, labor, and expense. This classification is essential especially in the estimation of work in progress or total cost. There are different ways of estimating these costs (Gwartney et al., 2017). For instance, labor cost can be estimated using direct labor hours.
Conclusion
In summary, cost classification is critical to understanding the relationship between economics and accounting. It enables economics to calculate and estimate costs over a period. Moreover, it helps in the determination of accounting and economic profit. Accounting profit is important to a firm since it helps to determine revenue received and monetary costs incurred by a firm. However, it omits the explicit and implicit costs such as the owner's salary. Economic profit is the total revenue generated from a business less explicit and implicit costs. Economic profit is only realized when earnings exceed opportunity cost.
References
Gwartney, J., Stroup, R., Sobel, R. & Macpherson, D. (2017). Microeconomics Private and Public Choice . Cincinnati, OH: South-Western Pub.
